Rent vs Buy: How to Run the Numbers Before a Mortgage

Whether to rent or buy a home is one of the biggest financial decisions most people make, and it is often settled by slogans: renting is throwing money away, or houses always go up. Neither slogan survives contact with the numbers. This guide shows how to compare the two options properly using a handful of ratios and a worked example. The figures are illustrative, so replace them with your own local prices, rates and taxes.

Renting Is Not Dead Money, and Owning Is Not Free

When you rent, your payment buys housing, and nothing is left over. When you own, part of your mortgage payment builds equity, but much of your spending is just as unrecoverable as rent: mortgage interest, property taxes, insurance, maintenance and the return you could have earned on the down payment. The right question is which option has the lower net cost for the period you expect to stay.

Step 1: The Price-to-Rent Ratio

Divide the purchase price by the annual rent for a comparable home. If a 400,000 home rents for 2,000 per month, annual rent is 24,000 and the ratio is about 16.7. A common rule of thumb is that ratios below about 15 favour buying, ratios of roughly 16 to 20 are a grey zone, and ratios above about 20 favour renting. It ignores interest rates and taxes, so treat it as a screening tool rather than an answer.

Step 2: The 5% Rule

A popular shortcut estimates that the unrecoverable annual cost of owning is roughly 5% of the home's value: about 1% for property taxes, 1% for maintenance and 3% for the cost of capital (mortgage interest and the return you give up on your down payment). On a 400,000 home that is 20,000 per year, or about 1,667 per month. If comparable rent is higher than that, buying looks favourable, and if it is lower, renting does. The 3% capital cost is an assumption, and when mortgage rates are high, it should be higher.

Step 3: A Full Worked Example

Take a 400,000 home with a 20% down payment of 80,000, leaving a 320,000 loan at 6.5% over 30 years. The monthly payment is about 2,023. In the first year, roughly 20,700 of the payments is interest and only about 3,600 reduces the principal.

Now add the other yearly costs of ownership using typical assumptions: property tax at 1.1% (4,400), insurance at 0.4% (1,600), maintenance at 1% (4,000) and the return you give up on the 80,000 down payment at 4% (3,200). Adding the interest of 20,700, the unrecoverable cost of owning in year one is about 33,900, or roughly 2,825 per month. Renting the equivalent home costs 2,000 per month.

On these numbers, buying is more expensive in year one, which the 5% rule would not have shown because it assumed a 3% cost of capital while this mortgage costs 6.5%. Now consider appreciation. If the home gains 3% in value, that is 12,000 of wealth, which cuts the net annual cost of owning to about 21,900, or roughly 1,825 per month, slightly below the rent. The conclusion flips depending on the assumption about price growth, and price growth is never guaranteed.

Step 4: Count the Transaction Costs

Buying typically costs 2% to 5% of the price in closing costs, and selling often costs 5% to 8% once agent fees and taxes are included. Those costs have to be spread across the years you stay. That is why financial planners often say you should plan to stay five to seven years or longer before buying makes sense.

Step 5: Compare Like with Like

Renting only wins fairly if the renter invests the difference. If you rent but spend the down payment and the monthly savings, you have not beaten the owner. Include the investment return on the down payment and on any month-to-month difference when you compare.

Check Affordability, Not Just Approval

Lenders often use guidelines like a 28% front-end ratio (housing costs as a share of gross income) and a 36% back-end ratio (all debt payments), but being approved is not the same as being comfortable. Keep an emergency fund of several months of expenses after the down payment, and test whether you could still pay if rates reset or your income dropped. Our article on loan EMI versus total cost shows how much interest long loans really add.

Non-Financial Factors

Owning gives stability, freedom to renovate and protection from rent increases. Renting gives flexibility, lower maintenance responsibility and less concentration of your wealth in a single asset. If you plan to relocate within a few years, flexibility often outweighs the financial case for buying.

Interest-Free Alternatives

Some buyers prefer to avoid interest-based mortgages. Islamic home financing structures such as Murabaha and diminishing Musharaka use cost-plus sales or co-ownership instead of loans. The same comparison still applies: add up the total cost over your expected stay. See our guide to Murabaha financing for how it works.

Use your own numbers

Replace the assumptions here with local figures: price, rent, mortgage rate, property tax, maintenance, appreciation and how long you will stay. If the answer flips when you change appreciation by one percentage point, the decision is close, and flexibility should count for more.